Income-oriented ETFs represent about $200-billion in assets under management.Phimprapha Kitaiamphaisan/iStockPhoto / Getty Images
Maple syrup, hockey and Mounties may be emblematic of Canadian identity, but a good argument exists for adding yield-focused exchange-traded funds to that list.
“Canadian investors have a really big appetite for yield,” says Raj Lala, president and chief executive officer of Evolve Funds Group Inc.
All told, income-oriented ETFs represent about $200-billion in assets under management (AUM), consisting of fixed-income, equity income and balanced income funds, based on a Q1 report from Toronto-based Investor Economics, an ISS Market Intelligence business.
Fixed-income ETFs still make up more than 78 per cent of those assets.
Yet, over the past 15-plus years of low bond yields, dividend funds have become “one of the most popular yield-oriented strategies in Canada in ETF land,” says Casey Yang, director of ETF sales and strategies at TD Securities Inc.
These account for almost $50-billion of the $1-trillion in gross AUM of all ETFs in the Canadian marketplace. But another type of yield-focused ETF has garnered almost as much investor capital in recent years, she adds.
“Increasingly, covered-call ETFs have been very popular because these offer much richer yields,” Ms. Yang says.
Today, more than 350 covered-call ETFs are listed on Canadian stock exchanges.
Most offer equity exposure with average indicated yields of 13 to 14 per cent, while a growing number of fixed-income covered-call ETFs offer yields of 8 or 9 per cent, she notes.
That’s compared with today’s bond ETF average yield of about 3 to 4 per cent and dividend ETF average yield of about 2.5 per cent.
“You can see why covered-call ETFs are shining,” she says, noting these funds account for about $48-billion in AUM in Canada.
Writing call options on all or a portion of the underlying assets, these specialty ETFs appeal to investors largely by paying out high yields as monthly distributions.
“Many investors gravitate to covered-call funds because they get equity participation and tax-efficient income,” Mr. Lala says, pointing to option premiums being taxed as capital gains.
Fund companies have taken note. Of Evolve’s 41 ETFs, 19 involve covered-call strategies, accounting for $4-billion of its almost $10-billion in AUM.
“These funds are equally successful with advisors in full-service brokerages and with investors directly in online/discount brokerages,” says Carlos Cardone, managing director for Canada at Investor Economics.
“Our distribution data usually shows a near 50-50 split between both distribution channels.”
The most popular fund by AUM is the longest-running: BMO Covered Call Canadian Banks ETF ZWB-T, which has almost $4.7-billion in AUM.
Demand for these ETFs has been surprising even for industry insiders. Mr. Lala points to the reception of Evolve Canadian Banks and Lifecos Enhanced Yield Index Fund BANK-T.
Evolve began eight years ago, focused on exposure to disruptive technologies, he says.
“If you had told me then that one of our biggest ETFs would be a Canadian banks ETF, I would have laughed at you.”
Yet, today, it’s one of the firm’s best-selling funds, accounting for more than one-tenth of its AUM.
Bank-focused covered-call ETFs may be among the most popular (and perhaps emblematic of Canadians’ dual love of yield and big bank stocks). Yet, the industry is continually innovating, creating new products to satiate Canadian investors’ thirst for yield.
Among them are “enhanced-yield” ETFs involving leveraged exposure of 25 to 30 per cent, which now make up about 37 per cent of all covered-call ETFs in Canada, Ms. Yang says.
Single-stock covered-call ETFs are an “increasingly popular version of those,” resonating with investors seeking exposure to technology and other stocks that don’t generate much or any dividend yield, she adds. To date, more than 100 covered-call single-stock ETFs are available on the Canadian market.
A recent launch, Hamilton Enhanced Bitcoin DayMAX ETF BDAY-NE from Hamilton Capital Partners Inc., offers exposure to Bitcoin. Nineteen of Hamilton’s 35 ETFs use covered-call and enhanced yield strategies, accounting for $11-billion of the manufacturer’s $17-billion in AUM.
But it also involves 25 per cent leverage, using that additional capital to invest in Invesco NASDAQ 100 ETF QQQM-Q. The Hamilton fund’s management team writes at-the-money call options daily on the Invesco ETF to generate tax-efficient premiums, says Nick Piquard, chief options strategist and portfolio manager at Hamilton ETFs.
“If you’re a holder of bitcoin and you want income, this is an innovative way to get yield.”
The fund also pays a cash distribution twice monthly, compared with a monthly distribution typical of most covered-call ETFs, which generally write 30- to 60-day call options.
It’s not just covered-call ETFs offering additional yield, says Daniel Straus, managing director of ETFs and financial products research at National Bank of Canada Capital Markets.
“There are a few put-write ETFs that have nice yields as well.”
These funds generally involve holding treasuries while writing put options on the stock market, generating yields of about 7 per cent, double the average treasury yield, he says.
Put-write funds are much less popular in Canada. BMO US Put Write ETF ZPW-T was the first, launching in 2017, and it has about $100-million in AUM today, the largest in “a pretty small field,” Mr. Straus says.
Covered-call equity ETFs remain the most popular specialty yield products in Canada, and “if current flow trends persist, there will be more AUM in covered-call ETFs in Canada than in dividend ETFs,” he says.
Growing popularity aside, it’s important investors recognize higher yields are not “a free lunch,” Mr. Lala says.
“The big drawback is you’re giving away some upside by selling calls,” he says. “Then again, there’s always a trade-off with anything you invest in.”